Wholesale Funding Instruments
This chapter explores how lower-income housing in emerging markets can be funded through wholesale sources, specifically through the capital markets and lender-to-investor channels. Access to wholesale finance can expand the supply of funds available for
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Wholesale Funding Instruments Michael J. Lea San Diego State University
Introduction This chapter explores how lower-income housing in emerging markets can be funded through wholesale sources, specifically through the capital markets and lender-to-investor channels. Access to wholesale finance can expand the supply of funds available for housing and manage the associated risks of lending. While the financial crisis of 2008–09 led to a collapse in wholesale funding worldwide, the use of this instrument will rebound as the global economy recovers. There are essentially four ways of raising funds for housing: (1) private equity, (2) private debt typically through wholesale funding, (3) deposits, and (4) government funded or directed credit.1 These are all forms of capital mobilization looking for a return, be it social or economic. The best way to raise funds depends on the expected return, operational costs and the ability of risk management. Equity investment plays a central role in funding private financial markets. Although equity is usually a small source of actual funding, it bears most of the risks. It is the cushion supporting both debt and deposit obligations of financial institutions. In wholesale finance, equity is the highest risk bearing class of security, a critical credit plays a central role in funding private financial markets. Private equity and hedge funds have been important sources of credit enhancement in subordinated securities and in specialized lending companies. As a result of the financial crisis, equity is likely to play a larger role in mobilizing both depository and securitized finance. Deposits are the main source of funding for housing globally. The importance of deposits is based on the dominance of banks and the retail nature of mortgage lending. In many emerging markets, expansion of mortgage lending has occurred with increasing commercial bank involvement.2 1
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See Diamond and Lea 1995 for a discussion. We will not deal with direct government funding here. For example, in China mortgage debt-to-GDP rose from less than 1% in the mid-1990s to more than 11% in 2005, mainly in the form of bank lending. In India and Mexico, the entry of banks has increased competition and the volume of lending.
D. Köhn and J.D. von Pischke (eds.), Housing Finance in Emerging Markets: Connecting Low-Income Groups to Markets, DOI 10.1007/978-3-540-77857-8_6, © Springer-Verlag Berlin Heidelberg 2011
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Michael J. Lea
However, the use of deposits to fund housing has limitations. Deposits are usually short-term with maturities of up to one year, whereas longer-term financing is needed to fund housing. This maturity mismatch subjects the lender to liquidity and interest rate risk. Deposit taking banks in emerging markets may experience volatility in their deposit base, creating liquidity risk. Commercial banks often use variable interest rate loans to manage interest rate risk, shifting that risk to the borrower and consequently increasing credit risk. The question is whether the saver, borrower
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